Archive for September, 2010
The Basel Agreement
Posted by Jody Eisenman | Filed under Uncategorized
Over the weekend, global banking regulators reached an agreement on steps to avert another financial crisis. The key reform was the raising of the tier one capital ration from 2.0 to 4.5%, plus a 2.5% buffer. Failure to adhere to these ratios would limit the banks’ ability to pay dividends. After modest rises the last two days, the stock market futures are solidly in the black this morning. One might think that Wall Street welcomes these reforms. My view is quite different; I think traders are happy that these reforms were actually quite weak.
What exactly is “tier one capital”? It is a measure of a banks’ equity capital to it’s’ risk assets. In layman’s terms, this means that at 2.5%, a bank could maintain fifty dollars in assets for every dollar it has is capital. That’s right, fifty to one! Currently, margin accounts go at two to one. The new ratio goes to seven per cent, or just 14.3 to 1. However, a closer look reveals the following:
Banks have eight years until complete implementation. As we have seen with the Lehman collapse, this could be an eternity of potential issues that could crop up.
There is no real financial penalty for the 2.5% buffer. Banks that do not maintain the buffer are not forced to raise capital. Thus, the real ration is going to be 4.5%, or 22 time’s capital. What that means in plain English is that if a financial institution’s risk assets were to deteriorate by 4.5%, they would still be effectively bankrupt. Furthermore, it will take five years to even get to this restrictive level.
I welcome these reforms as absolutely necessary. However, I question whether this is simply too little, too late. Let’s hope we don’t have to find out.
The Euro zone Issue
Posted by Jody Eisenman | Filed under Uncategorized
Generally speaking, the phrase “As go financials, so goes the market” holds true. Year to date, the Dow Jones is down a bit less than 1 per cent for the year. The financial stocks, as tracked by the XLF exchange traded fund (ETF), are down about 1.5%. I have usually spoken about the US banking situation. However, the market action yesterday (a drop of over 100 points) was fueled mainly by the European banks. In 1993, 27 different countries got together to form the European Union or EU. The stated goal was to develop a single standardized market for goods and capital. As such, the European Central Bank was established in 1998 in order to administer monetary policy. In a perfect world, the stronger countries would help the weaker ones, this insuring overall growth for everyone.
Unfortunately for the member nations, things didn’t work out quite as planned. What history has shown us is that although countries will sometimes help others, every country’s primary goal is their own self interest. What you have going in the EU now is that several of the weaker countries (such as Portugal, Ireland, Greece and Spain, affectionately known as “PIGS”) are heavily in debt to the stronger nations like Germany and Switzerland. These countries have been spending well beyond their means for years, and when the recession hit, they fell into deep financial difficulty. What has compounded the problem is that most of these countries tend to be socialist, and many of the expenses are in lavish salary and pension benefits to union and government employees. In order to balance their budgets, cuts have to be made (or taxes raised), which was met by the inevitable strikes and riots. Many investors are now rightfully concerned about the health of not only the weaker countries, but the banks that lent them the money. After all, if one or more of these countries defaults on their debt, how would these banks get repaid? Of course, having these banks’ leveraging their capital structure severely increases the problem.
Meanwhile, my central theme has remained the same. The market continues to trade in a relatively narrow range. Barring an extraordinary event, I do not expect this situation to change for awhile.
Great News: More People Out of Work
Posted by Jody Eisenman | Filed under Uncategorized
The much anticipated unemployment number was released this morning. Unemployment rose to 9.6%. However, private payrolls rose, which signaled to some that the recession may be easing. If it is, I don’t see it. The financial sector continues to lay off people. Investment banking has slowed dramatically. In addition, the underemployment rate (which includes part timers who can’t find full time work and people who have given up searching) increased to 16.7% from 16.5%.
However, the stock futures have soared on the news, reason being that analysts were expecting a complete collapse. So, the bad news is really not that bad, which means its’ good. Did everyone understand that? Currently, the S and P is trading at around 1100 in the pre market. This may be a key level, as a strong move through it could signal a great third quarter. However, the trend this year has been choppy, so anything is possible going forward.
Happy Labor Day to all!
